The Promise of Social Impact Bonds

When a government needs to invest in an expensive capital project — a new sewer system, bridge or highway — it issues bonds. Bonds raise upfront money from private sector investors, who are then paid back with interest from the tolls or charges the project will generate.

Until now, no one ever issued a bond to invest in people like Popeye.

Popeye is a short, bearded man of 59 who often wears an earring and a cap.His real name is Robert Innes, but he acquired the nickname 25 years ago in prison. He started drinking at 13, and three years later began living on the streets, which continued until November of last year. When he was on benders, Popeye would steal beer and panhandle aggressively. His untreated heart problems would land him in the emergency room unconscious, and when he woke up would start a fight. He also gave new meaning to the term “repeat offender.” He said he has been incarcerated in his home town of Norwich, England, 118 times, and in Peterborough, about 75 miles west, where he lives now, 48 times.

Popeye used the prison system for housing, the emergency room for basic medical care and the courts as his support system.

This lifestyle is more than a tragedy for Popeye; it’s a tragedy for taxpayers.Just to keep Popeye alive —never mind helping him to change — was hugely expensive. Governments would prefer to prevent people from cycling over and over through prisons, courts, homeless shelters and hospital emergency rooms. And they know that there are interventions that are proven to help and to save money. But these programs are expensive enough that cash-strapped governments usually can’t begin them. Cities are so stretched — in part from providing acute care to people like Popeye — that they have nothing left over for prevention.
A brand-new financial instrument may provide a way out of this dilemma. In September, 2010, in Peterborough, a town about an hour’s train ride from London, the first test began of a new idea that in a very short time has caught the attention of governments around the world. They see it as a way to provide third-party upfront money for prevention programs they might not otherwise be able to afford. The idea is called the social impact bond.

It has transformed Popeye’s life. At Christmas, Popeye got the keys to an apartment, and he has proven to be a meticulous housekeeper. He had help learning how to live in an apartment — how to connect utilities and manage his bills. His caseworkers helped him to get an ID card and bank account, and register with a doctor so he could use Britain’s National Health Service. They went with him to appointments and took him shopping (he had been banned from most local stores for his antisocial behavior). He got psychological counseling. He was encouraged to become a volunteer. He is starting cooking classes.

Thomas BlackwellRobert Innes, known as Popeye.

Popeye is still drinking, but less now. He hasn’t been arrested since October — before he started the program.

The help comes from a new organization called the One Service, which has brought together four social service groups to provide comprehensive assistance to men released after serving short-term jail sentences at Peterborough Prison.

Convicts leave prison in Britain with £46 in their pockets and nothing more; often, they walk out of the prison gate alone. The One Service meets everyone in Peterborough at the prison gate, even the prisoners who didn’t sign up for the service. They go to breakfast — usually at McDonald’s, at the men’s request — and then to the office. “Sometimes you see the person inside prison and he says, ‘I don’t need help,’” said Janette Powell, who runs the One Service. “But when you meet them at the gate they say ‘I’m glad you turned up.’ ”

What’s new about the One Service isn’t what it does, but how it is financed — by the sale of bonds. The idea comes from various thinkers, social service experts and captains of industry in Britain who formed a group called Social Finance to build a social investment market there. It raised £5 million — about $8 million — from 17 investors in Britain and the United States, The investors will get their money back only if One Service succeeds. The bondholders are mostly charitable groups who would normally give money away; they were willing to be guinea pigs because of their desire to see this financial instrument succeed.

Over the next six years, the recidivism rates of men released from Peterborough (all of them, not just the ones who become clients of the One Service) will be compared to the recidivism of a matched group of prisoners elsewhere. If Peterborough’s re-conviction rates are 7.5 percent less than the control group,the British government will repay the bondholders with interest. (If that threshold isn’t met, investors lose their money, which means that technically it is not a bond.) The better the recividism rates, the larger the payout for investors, which is capped at the equivalent of 13 percent per year over an eight-year period.

The first interim data on recidivism rates won’t come out for two years. What we know now is that large numbers of recently released prisoners are using the program, and that anecdotal reports from police in Peterborough indicate that the kind of crimes these men commit is down — police have told One Service staff that they were startled to hear that certain of their repeat offenders were, in fact, still alive.

Social impact bonds are the latest illustration of two new and welcome trends in social services. One is measuring outcomes, not outputs. The number of people counseled is an example of an output. That may or may not be a marker of success, but it usually becomes the benchmark because it’s easy to count. Measuring outcomes, such as less recidivism, is, of course, the test of whether a program is working, but it is often very hard to do. Sometimes outcomes aren’t visible for many years. And it can be hard to know what made the difference without a randomized controlled trial — far too expensive to be realistic. The other trend is paying only for success: if the program doesn’t work, the taxpayers can tear up the bill.

Massachusetts will be the first place in the United States to try one. The state is hoping to sign contracts this summer to back $50 million in bonds for two projects:one to help people coming out of the juvenile justice system make the transition to adult life, and another to house the chronically homeless.

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Jay Gonzalez, Massachusetts’ secretary of administration and finance, said that the expense of paying for shelters and prisons now leaves nothing left over. “We’re cutting the shelter budgets, so it’s even harder to find resources to invest in preventive solutions before we can realize the savings,” he said.

“We have a new fiscal reality in government,” said Gonzalez. “We have to find new and innovative ways to get better results at less cost. We don’t have a choice at this point.”

In last year’s budget, the Obama administration proposed spending $100 million to try these and other pay-for-success programs. Congress voted it down, but the administration is trying again, and will be starting pilot programs this year inside the Justice and Labor departments.

Other states as well — including New York — are exploring the bonds, or variations on them. New York City has been working for more than a year on developing a bond to help people coming out of the juvenile justice system stay crime-free. Tracy Palandjian, the chief executive of Social Finance US, says the organization has talked to “well over 30” jurisdictions interested in social impact bonds. And countries like Australia, Canada and Israel are looking at them, too.

Most of the pilots focus on cutting crime and homelessness — two issues that have interventions we know work, and we know save money. In addition, they offer outcomes that can be measured in the medium term — important, because these determine whether investors get paid. A prison project was chosen for the pilot, in fact, because it was relatively easy to measure recidivism. Peterborough has a large number of people serving short sentences, and when they get out, they tend to stay in the community. “We wanted to fund something with a clearly defined outcome,” said Alisa Helbitz, the director of research and communications at Social Finance in London. “You can’t measure ‘well-being.’ ”

Gonzalez, however, said that if the pilots are successful, Massachusetts will expand into other areas, perhaps higher education. There are also possible applications in health — for example reducing re-hospitalizations, diabetes prevention, or keeping the elderly in their homes as they age.

Even poor-country development projects might be suited to bonds. Social Finance in Britain is now working with the Center for Global Development, a Washington think tank, to explore ways that bonds could be used to finance projects such as preventing disease or installing clean water systems.

There are various ways social impact bonds could create a more intelligent approach to social programs. Typical social programs usually end up focusing on the easy cases — so their success rates stay high. Social impact bonds have the reverse effect:they provide an incentive to help the really hardest cases. Popeye’s future criminal activity is going to be counted whether he’s a client or not — so it’s a good idea to work with him.

Social impact bonds could also make service work more rational. Like politicians, nongovernmental organizations are constantly fundraising. Financial uncertainty can rob them of the power to plan more than a few months ahead. Social impact bonds could give them the up-front money they need to be effective, and they can use the money however they think appropriate to meet their targets.

A recent study by the consulting firm McKinsey points out some of the challenges. The complex structure of these bonds adds layers that makes them more expensive than simply having the government pay for the services directly. And in some cases, the financial benefits to the government may depend on hitting a certain threshold — incarcerating fewer prisoners, for example, is only cheaper if the reduction is big enough to allow a prison to close a wing and cut staff. The Peterborough pilot, in fact, may be too small to save the government money from reduced incarceration, although if it is successful, a scaled-up version certainly would. But the government might save money, even in the small pilot, in reduced use of courts and emergency rooms.

The excitement around social impact bonds — and there’s a lot of it, judging by the number of jurisdictions looking seriously at them, is unusual for a project that only exists in one town in Britain and has yet to show any results. “It adds a whole new meaning to the idea of faith-based initiatives,” said Bill Pinakiewicz, vice president of the Eastern region of the Nonprofit Finance Fund, a group which provides loans and strategic help to nonprofits.“But there’s a real breakthrough here. Social impact bonds established that there is economic value to positive outcomes being delivered to families, individuals and communities in need. It creates a dollar value that can be used to pay back investors. They have real economic value and attract financing — like breakfast cereal and software.”